Starting a new business can often become an overwhelming task and it is easy to overlook important legal safeguards. However, without arming yourself with some legal knowledge, you may find your business in some hot water down the road. Luckily (or unluckily), enough small business owners ahead of you have made mistakes that you can learn from. This article will address some of the most common legal mistakes business owners make while launching their entrepreneurial career.
- Creating the wrong kind of ownership structure and not following the obligations of that structure. You can choose to form your business from one of several different legal ownership structures. The tricky part is to pick the right type of structure. It usually boils down to (a) how many owners will be in your business, (b) what the tax consequences are, and (c) your personal liability in each structure. You should take the time to research the pros and cons of each structure and consult a tax and/or legal professional to help guide your business in the right direction. Each structure has its own set of rules you need to follow. For instance, a corporation requires you to have shareholders and a board of directors. You also have to completely separate your personal finances from your business finances. You will find yourself in a lot of trouble if you co-mingle your funds because in the event of an audit or litigation. Courts and government entities view you actions this as “piercing the corporate veil.” This essentially means you are personally liable for any debt or damages owed.
- Having no written partnership agreement. If your business has co-owners, this contract may just be the most tedious but most important one to draft in the beginning of your business. This agreement outlines all the responsibilities and potential issues between the owners. A partnership agreement does not just apply to a partnership structure; if you are a corporation, this agreement between the owners is known as an operating agreement. You and your business partners need to discuss and dissect all the possibilities. Some issues to consider are: who has the authority to make certain kinds of decisions, what kind of decisions require a majority or unanimous decision, and what happens when someone leaves the business? If these issues are not clearly outlined in your partnership agreement, you can expect tension and conflict between your partners in the future.
- Not understanding the law. In the US, there are laws within laws. In other words, all businesses need to abide by the local, state and federal laws. If you do not understand or abide by the law at each jurisdictional level, you may run into problems. A common example is with business permits. Often times, small business owners will believe they only need to apply for a state permit or a local city permit. However, this is usually not the case; businesses generally need to register with the local government, with the state of incorporation and where they do business, and the federal government. Other times, not knowing the laws of any jurisdictional level can be problematic. For instance, in California, non-compete agreements are void by law. If you did not know this or did not fall into one of the exceptions, you will find yourself in a vulnerable position with a competitor. Be sure to ask for clarification from government agencies and consult with your local SBA (SBA.gov). They can help you find out more information about the different regulations to better protect and manage your business.
- Not using non-disclosure agreements or non-compete agreements. If you want to protect your business’s propriety information, you need to use the right documents with the folks you interact and work with. When you deal with potential investors or employees, arm yourself with a non-disclosure agreement so they can’t steal your company information for their own financial gain. When you decide to hire employees for your company, be sure to have them sign a non-compete agreement. You don’t want to find yourself competing against an ex-employee because he decided to take what he gained from your business to start a competitor company.
- Ignoring intellectual property rights. This common legal mistake works both ways. Small business owners often will overlook the importance of intellectual property rights. Some may think that there are no consequences by using another company’s trademark or patent. Many companies are very vigilant of trademark or patent infringements. If they catch you, you may at the mercy of a lawsuit and fines. On the other hand, other business owners believe there is no reason to apply for patents and trademarks. Especially when funds are tight at the onset of a new business, it is easy to put filing expensive trademarks and patents on the backburner. But you need to remember that patents and trademarks are the core and identity of your business. If you don’t protect them from the beginning, it will be easier for others to take advantage of your company later on.
There are many other legal pitfalls that may come your way if you do not do your research. The ones I’ve listed are just some of the mistakes small business owners make. I highly recommend reaching out to other established business owners for their advice. Also, don’t hesitate to reach out to legal and accounting professionals to help you through this process.